27.04.2011

The Japanese nuclear disaster has seen some countries announce halts to nuclear power programmes over safety concerns and there are doubts about the future use of nuclear power in some countries, especially in Europe. What does this mean for the future, near and long-term, of power utilities with non-nuclear generation capacities?


It looks pretty clear that Fukushima is going to mark a major turning point in public support for nuclear power in much of Western Europe and to a lesser extent the US. The level of public support for nuclear power is dramatically different across different countries in Europe however. Whilst a large proportion of Germans are strongly opposed to building new reactors and want to close down the country’s nuclear fleet as soon as possible, conversely, public support for nuclear power is strong in France – where nuclear power accounts for around 75% of power generated.

In the near term, we are likely to see many older nuclear plants in particular, close for safety inspections - as has been the case in Germany, where seven of the country’s seventeen nuclear plants have been shut for three months whilst inspections take place. Inevitably, this will lead to significantly higher power prices and higher prices for carbon emissions permits, particularly in Germany (which we have already seen) and surrounding areas. This is good news for power generators with a significant non-nuclear base load generation capacity. Generators with coal-fired generation will benefit somewhat, but the big winners will be generators with low cost combined cycle gas-fired generation and those which run off river hydroelectric generation capacity (who won’t face the burden of higher carbon prices), particularly those connected to the German power grid.

In the longer term, governments across Europe and the US are likely to issue very few approvals to build nuclear plants. The 1979, the nuclear accident at Three Mile Island in Pennsylvania froze the nuclear power industry in the U.S. No new licences to build nuclear plants were granted for 30 years. The Three Mile Island incident -- sparked by the failure of a cooling system -- did not cause any deaths, but many Americans were terrified by the plant's move to vent radioactive steam into the air and by ominous talk of a potential meltdown. At the very least, I would expect any applications to build nuclear plants that are currently before regulators in Europe or the U.S to face long delays and many of them not to be approved. In addition to this, I would expect far greater regulatory scrutiny of existing nuclear plants that are seeking to extend their operating licences, especially when those plants are located in seismically active zones.

With CO2-emitting coal-fired plants generally unpopular with voters, gas-fired plants will comprise the bulk of new power stations built – whether that be to meet new demand, or to replace old capacity being retired from service. So demand for gas and gas prices are likely to rise and energy security in Europe is going to become even more of an issue for politicians.

How will this affect the Fund?


Going into the crisis, the Fund had only a small position in utilities with nuclear generation capacity in Europe, as we were concerned by the political uncertainty surrounding nuclear generation in Europe and in Germany in particular. This meant that the crisis had very little impact on the Fund and was in fact one of the main reasons we outperformed our benchmark index significantly when the crisis at the Fukushima plant occurred. We’ve used the crisis as an opportunity to significantly increase our holdings in generators with gas-fired and hydro-electric generating capacity, and, to a lesser extent, generators with coal-fired generating capacity.

The Fund has a percentage of its portfolio invested in Japan. How will the recent events, including the need for Japan to invest massively in rebuilding, affect the Fund specifically?


The crisis proved to be a great opportunity to increase our weighting in Japan at good prices. Prior to the crisis, 5% of our fund was in Japan, whereas we have now increased that weighting to 9%. The additional investment has been in companies operating gas-fired generation, coal-fired generation and hydroelectric generation capacity.

Not only has the Fukushima reactor been shutdown, but 13 of the 17 nuclear plants operated by Tokyo Electric Power (the operator of the Fukushima Daichi plant) have been shut down, as well as both of the coal-fired plants and ten of the twenty oil-fired plants operated by the company. Tokyo Electric Power (TEPCO) produces almost 30% of Japan’s electricity. One fifth of TEPCO’s capacity (which represents 6% of Japan’s total power generation capacity) has been shut down permanently and a further 15% of the company’s capacity (4% of the nation’s capacity) has been shut for a significant amount of time. Add to this the fact that many of Japan’s older reactors are likely to undergo temporary shutdowns (as has already happened in Germany) over the next few years. The power shortages are so dire that the government is expected to exercise a legal provision not invoked since the 1974 oil shock, to restrict electricity use this summer to just three-quarters of last year’s level. So it’s pretty clear that there are going to be power shortages in Japan for many years. This represents a great opportunity for power generators operating gas-fired generation, coal-fired generation and hydroelectric generation facilities, who are likely to make excess profits for a long time.

With this in mind, do you plan therefore to increase or decrease the portfolio’s share in Japan and over what time frame?


We’re pretty happy with the weighting we have to Japan at the moment, whether we increase or decrease that in future will depend on how prices move.


When there are significant events which affect a single sector, such as the Japanese nuclear disaster which affected local and global power sectors, what approach do you take to investment in that sector?


It’s very much a case by case basis, but typically the best investment opportunities occur in times of panic like we’ve just seen. When panic sets in, market participants tend to shoot first and think later, so there are inevitably opportunities to buy stakes in companies that are relatively unaffected by the crisis, or who might even benefit from it, at discount prices. It does require you to have a fair bit of courage in your convictions to buy when everyone else is selling, but that is after all what you get paid for.


Governments and companies in many Western countries are pushing to reduce energy use generally. What impact will this drive to be energy efficient have on power utilities and, subsequently, on prospective investments in them?


Utilities are natural monopolies and are highly regulated, which results in them having stable earnings, regardless of whether economic conditions are strong or weak. Utilities’ earnings are actually more dependent on regulation than they are on the amount of power they sell. Across the western world most utilities regulators (if they haven’t already implemented it) are moving towards a concept called “revenue decoupling”. This is just a fancy way of saying that a utility’s earnings are not dependent of the amount of power they sell, but on the amount they invest in
infrastructure. Because governments want to encourage utilities to invest more in energy efficient transmission and distribution technology and to encourage them to encourage their customers to use less power, not more, they are implementing a regulatory framework that means utilities are not penalised if power consumption falls.


Some investors have lauded utilities for their performance in the face of the economic crisis of the last few years. Have utilities significantly outperformed other investments in recent years and, bearing this in mind, are they a good long-term investment?


Over the last twenty years, an investment in utilities and infrastructure has outperformed an investment in equities by around 2% per annum and with a lower standard deviation of returns. Over the last couple of years, utilities have lagged the broader market, which is to be expected. The utilities sector tends to outperform the rest of the equities market more when economic conditions are weak and when stock markets perform poorly and to underperform when economic conditions are weak and when stock markets perform well. This is exactly what makes them a good addition to an investors’ portfolio.

 

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